A company that is considering going public has a long road ahead filled with decisions. When the business currently is structured as a partnership, it has been historically assumed that it should become a corporate entity before the initial public offering (IPO). However, businesses operating as partnerships can take an alternate route to that destination that may yield significantly more value: the Up-C partnership structure.
The Up-C partnership structure is often overlooked but may be a highly advantageous path to an IPO in the right situation. With it, the existing partners may defer recognizing taxable gain and increase their total consideration received on future disposition of partnership units by creating certain tax attributes and subsequently monetizing the associated benefits in the form of cash received as the tax attributes are used.
In the Up-C structure, the business forms a C corporation and raises capital on the public market via an IPO. The C corporation, in turn, contributes the capital generated from the IPO to the capital of the existing partnership (operating partnership) in exchange for interests in the operating partnership. Effectively, the C corporation (public company) serves as the publicly traded vehicle and invests in the operating partnership. The public company is a holding company, as it owns an interest in the operating partnership alongside the pre-IPO partners (legacy partners). As part of the structure, the public company typically becomes the managing member of the operating partnership.
The legacy partners, who will continue to own an interest in a partnership, will benefit from the flowthrough treatment of income and will avoid the burden of double taxation that typically applies to corporations. Further, by maintaining the flowthrough treatment and increasing their outside tax basis in their operating partnership units over time by their share of the operating partnership's taxable income each year, the legacy partners will avoid double taxation on the ultimate disposition of their operating partnership units. The legacy partners will also benefit from the liquidity of a public market via an exchange mechanism by which they can exchange their partnership units for public company stock, as further described below.
As part of the overall structure, the legacy partners will typically have rights to exchange their partnership interests for stock of the public company, which they can sell for cash in the public market. In some cases, the public company may have the right to purchase the legacy partners' interests for cash rather than issuing its stock. When coupled with a tax receivables agreement, the Up-C structure becomes a powerful tax planning tool that can significantly increase the ultimate proceeds realized by the legacy partners upon exiting their investment in the operating partnership.
For a detailed discussion of the issues in this area, see "An Alternate Route to an IPO: The Up-C Partnership Structure: Part 1," by Jeffrey N. Bilsky, CPA, and Avi D. Goodman, CPA, in the November 2015 issue of The Tax Adviser.
—By Alistair M. Nevius, editor-in-chief, The Tax Adviser
The Tax Adviser is the AICPA's monthly journal of tax planning, trends, and techniques. Also in the November issue:
- A look at a net investment income tax anomaly.
- A discussion of like-kind exchanges of intangibles.
- An analysis of Sec. 752 and partnership cancellation-of-debt income.